Thursday, April 16, 2009

The crisis is passing (2)

I last posted on this subject December 22nd. Here's an update on one of the charts I included in that post: the ratio of the VIX index to the yield on 10-year Treasuries. It's fallen by about 50%. Instead of signaling unbelievably dire conditions, as it was last November, it is now saying that we are just about getting down to the conditions that have prevailed during the worst of recent recessions. The market is effectively saying that instead of staring a record-breaking depression in the face, we are now looking at one of the worst recessions in recent times. That just about summarizes how I see the recent rally: it's not that things have turned positive, it's that things are not turning out to be so awfully horrible as people had been expecting. If the economy actually does take a turn for the better, there is a tremendous amount of upside left in this market.


Rob said...

I'm going to play devil's advocate again Scott ! Look at that chart another way: imagine it was the stock price of an explosive growth stock. It has skyrocketed and then been hit by a lot of profit taking plus some nervousness, but soon enough it will be back on its upward trajectory. I'm not trying to be facetious, just to make the point again that when we extrapolate from charts, we must of course be aware of the dynamics of charts and charting. No ? As a PS

I'd also be interested on your view of the UK, where I live as a humble servant of Her Majesty ! The £ has benefited from this recent rally in stock markets and now seems to be a direct play on whether or not the world economy is recovering. If the bears come out to play again, down goes Sterling ? Do you have any strong views on UK inc. ? Thanks again Scott.

Anonymous said...

Good post, and comment. Something I find interesting is how many economists are saying the recession actually started back in what 2006? So we have been in this for 3 years to date? If so that would be one of the longest? I think when you consider history we have to take into consideration current situations. Meaning the economy and world are so much different from 10 years ago, I am reading a blog about the economy, things change so fast today because information is instantaneously transfered. People hear about earnings, profit, loss, possible mergers etc. On twitter while they are still being discussed in a board room. So the markets change so quickly, who's to say we won't see a turn around and watch our unemployment rate turn around for the better in the next 6 months?

Scott Grannis said...

Rob: I'm not sure your analogy is a good one. The Vix cannot sustain an extremely high level for ever, and it can't go ever higher. It must come down sooner or later, unless we reach the end of the world as we know it. Similarly, the 10-yr has bounds for practical purposes, and is highly unlikely to go to a zero yield. So this ratio must have a sort of mean reverting tendency to come back down to levels that are lower than we are at today.

I'm not a chartist and I don't base decisions on my reading of a chart. What I like to see is a range of fundamental indicators pointing in one direction or another. This ratio would be one of those indicators. The art of using indicators is just that--it's not a science.

I see a lot of things pointing the right way, and I see this ratio clearly evidencing a reduction in fear and safe-haven demand. Gold has come off its highs. Commodity prices are all turning up. Shipping rates are turning up. Swap spreads are declining. Taken together they add up to a bullish case.

Sure, this ratio might take off again if everything went the wrong way again. But I think it is telling us that at the very least our worst nightmare has come and gone.

As for £, I see it as very close to its PPP vs. the dollar. So I think it's at a reasonable level today after "overshooting" a bit to the downside earlier this year. Interest rates in the US and the UK are fairly closely aligned. Equities are having similar difficulties. I end up thinking there are too many similarities between the two countries to expect any major changes in current relationships. If stocks turn south, however, the dollar might well rally, and that would be bad for £ as it was earlier this year. I've commented on the inverse relationship of the dollar and equities, and admit to still not fully understanding it, so I would be reluctant to say I have much confidence in all this.

Scott Grannis said...

cribs: I'm one of those economists who didn't think the recession started until well into the first half of last year. The super-bears were the ones saying the recession started in '06, and I'll met most of them see worse things yet to come. We all make mistakes.

I agree that today's information flow changes things dramatically. It may accentuate panics, as we have seen in recent months, but it may also shorten adjustment times. I'm guessing that those who are still bearish are underappreciating just how much and how fast the underlying dynamics of the economy and the market are changing. As you say, later this year we may discover that the recession ended in March/April.

Cabodog said...


I'd generally agree with your observations that we've seen the worst. The bulk of the nation's businesses are now very lean and poised for any type of rebound, which means good profits ahead.

However, one thing bothers me and that's commercial real estate. I think there's a storm brewing there as tons of debt matures and no way to refinance it (the collapse of MBS markets and also lower occupancies due to the recession making it harder to refi also). GGP went bankrupt today due to those issues -- how many investors will face these same issues over the next 12-24 months?

However, the market seems to have the CRE issues priced into it, with banks still at rock-bottom pricing, the market anticipating higher losses from CRE.

The Lab-Rat said...

Scott, in the past you have frequently pointed to T-Bill yields rising to support your 'more optimistic than a very pessimistic market' view. What do you make of USGG1M back at or around zero despite encouraging signs elsewhere in the markets?

Scott Grannis said...

Re: CRE. It's no secret that CRE is in trouble. It's making headlines everyday everywhere. Yet the market shrugs off the bad news. I conclude that the market has priced in a CRE debacle. But if the economy as a whole has seen the worst of the recession and starts to improve, that will make the CRE situation much less problematic.

The key thing for me is that not too long ago the market was priced to a double-deep-deflation depression. Now it's just priced to an awful recession. If we get a mild, modest recovery, the sky's the limit for equity prices.

Scott Grannis said...

Lab-Rat: I've been pondering that same question myself for the past few weeks. I don't have a good answer, otherwise I would have posted something on it. My best guess right now is that with all the $$ that the Fed has poured into the system, a good portion of it is just sitting in cash and T-bills. People don't have the courage yet to deploy the money into riskier assets.

I imagine the owners of all those T-bills are beginning to get extremely nervous as they watch equity prices melt up. When bill yields rise we will know that their nerves have got the better of them.